I received a follow-up question about this in my inbox from a reader:
What are the investment implications of your inflation chart? Should I own more or fewer shares if inflation is higher?
Good question.
Here’s a follow-up chart showing annual stock and bond returns with their corresponding inflation rates:
Higher than average inflation did not hurt the stock market in the 1920s.
Sure, there was a bear market in 2022, but this is the highest inflation rate since the 1980s and the stock market is growing at 15% per year.
The stock market also did well in the 1980s with relatively high inflation.
Inflation averaged 5% that decade, but the stock market returned more than 17% annually.
The 1970s are the nightmare scenario where sky-high inflation gets to you. Real returns were negative throughout the decade.
The difference is that inflation rose throughout the 1970s and fell from the high levels of the 1980s.
Bonds also did well in the 1980s, but lagged behind in the 1970s, as did the stock market.
But bonds have taken a beating in the 2020s.
Inflation is the biggest risk for government bonds over time, but fixed income returns are also affected by initial yields and the direction of interest rates.
There is no simple formula here.
If you’re a glass-is-half-empty person, look at my chart and point out the fact that in two of the last eighty decades, stocks have truly lost a decade behind inflation.
That’s painful.
The glass half full version holds that the stock market has risen 11.7% per year since 1950. Take away the average inflation of 3.5% over that time and you get a real return of 8.2% per year.
More than 8% better than the inflation rate seems like a pretty good long-term hedge to me.
I don’t know if this will repeat itself in the next 75 years, but the stock market remains your best defense against inflation in the long term, even if that isn’t always the case in the short term.
Further reading:
Inflation will not return
#hedge #wealth #common #sense